Private Company Mergers and Acquisitions: Understanding valuation

A merger and acquisition (“M&A“) is a big step, creating bigger companies from smaller ones. News about M&A can affect the corporate investment and finance world because of the impact on the financial environment. M&A is a rigid process that starts with determining the benefits of taking over one company or merging it with another existing company. The issue that is often considered is the valuation of the company being acquired or the companies that are merged.

In an M&A deal, the participants have their own basis for the valuation of the company. The seller puts a high price tag while the buyer wants a lower tag attached to the company.

The assessment or valuation by both sides may be legitimate and correct based on the perspectives that their perspective. There are even tools that can be used in assessing the company, such as the use of comparative ratio, replacement cost, and discounted cash flow.

The comparative ratio valuation approach considers the price-earnings ratio or P/E ratio. Here, the buyer offers a price based on some multiple of the company’s earnings. The present market condition will be considered with reference to other companies in the same line of business.

Another consideration can be the enterprise value to sales ratio, or EV/Sales ratio. Here, the basis is the multiple of the revenues in consideration of the prevailing market prices in the same industry. Again, a study of the company market share will be considered in the valuation.

Replacement cost is an approach of setting the cost based on the premise of replacing the company. This is the sum total of all the assets and staffing costs. Although this is very simple, this approach may not be the best to use when the industry involved is an area where human resources development requires high investment cost. Getting the sum of all equipment and human resource costs will not be reasonable for this particular industry.

Lastly, discounted cash flow (DCF) can be used as an estimate of future cash flows. There are financial tools that can be used to come up with the exact value. A thorough study of the company’s financial records will be necessary to come up with the valuation.

Regardless of the approach that will be used in the valuation process, it is important for a business legal services to be available in the private company merger and acquisition transactions.

There are business laws that need to be considered in the process, and the insights and advice of business law experts will be indispensable at this stage. Aside from this, the necessary documentation and compliance requirements for government regulations will be taken care of.

For valuation assistance, business legal services can blend well with financial advisers. This can even be provided as part of the business legal service for processing M&A requirements. Expert advice and assistance will ensure the transaction is completed successfully. This is something that should be considered in every M&A transaction for a smooth process of take-over and turnover.


10 February 2012